Understanding Right of First Refusal in Philippine Lease Contracts

TLDR: This case clarifies that a right of first refusal granted to a lessee in a lease agreement is not automatically transferred to a sublessee, even if the original lease contract is referenced in the sublease agreement. The lessor’s consent is crucial for the assignment of such rights.

G.R. No. 128119, October 17, 1997

Introduction

Imagine you’re running a successful business in a rented space, and your lease agreement includes the coveted right of first refusal – the chance to buy the property if the owner decides to sell. But what happens if you sublease part of that space? Does your sublessee automatically inherit that right? This scenario highlights the complexities surrounding the right of first refusal in lease agreements under Philippine law. This case of Murli Sadhwani, et al. vs. The Honorable Court of Appeals, et al., delves into this very issue, clarifying who truly holds the right to purchase the property when a lease and sublease are in play.

In this case, the Sadhwanis, as sublessees, claimed they had the right of first refusal when the property they were renting was sold to Silver Swan Manufacturing Co., Inc. They argued that because their sublease contracts incorporated the original lease agreement, they were entitled to the same right of first refusal granted to the original lessee, Orient Electronics Corp. The Supreme Court, however, disagreed, setting a crucial precedent for lease and sublease arrangements in the Philippines.

Legal Context: Lease Agreements and the Right of First Refusal

Philippine law governs lease agreements primarily through the Civil Code. A lease agreement is a contract where one party (the lessor) allows another (the lessee) to use a property for a certain period in exchange for payment. The right of first refusal is a contractual right granted by the lessor to the lessee, giving the lessee the priority to purchase the property if the lessor decides to sell it.

Article 1311 of the Civil Code establishes the principle of relativity of contracts, stating that contracts bind only the parties, their assigns, and heirs, except in cases where the rights and obligations arising from the contract are not transmissible by their nature, or by stipulation or by provision of law. This means that a contract generally cannot impose obligations on someone who is not a party to it.

Article 1649 of the Civil Code specifically addresses the assignment of lease agreements: “The lessee cannot assign the lease without the consent of the lessor, unless there is a stipulation to the contrary.” This provision emphasizes that the lessor’s consent is generally required for the lessee to transfer their rights and obligations under the lease agreement to another party.

In relation to subleasing, Article 1650 of the Civil Code provides: “When in the contract of lease there is no express prohibition, the lessee may sublet the thing leased, in whole or in part, without prejudice to his responsibility for the performance of the contract toward the lessor.” Thus, unless expressly prohibited in the lease agreement, a lessee can sublease the property.

Case Breakdown: Sadhwani vs. Court of Appeals

The case unfolded as follows:

• Homobono Sawit leased his property to Orient Electronics Corp., granting them the right of first refusal.
• Orient Electronics Corp. then subleased the property to the Sadhwanis. The sublease contracts referenced the original lease agreement with Sawit.
• Sawit sold the property to Silver Swan Manufacturing Co., Inc. without offering it to the Sadhwanis first.
• The Sadhwanis sued, claiming they had the right of first refusal because their sublease contracts incorporated the original lease agreement.

The Regional Trial Court initially ruled in favor of the Sadhwanis, but the Court of Appeals reversed this decision, stating that there was no assignment of Orient Electronics’ right of first refusal to the petitioners. The Supreme Court affirmed the Court of Appeals’ decision.

The Supreme Court emphasized the principle of relativity of contracts, stating that the right of first refusal was granted to Orient Electronics, not the Sadhwanis. The Court noted that while the sublease contracts referenced the original lease agreement, this did not automatically transfer the right of first refusal to the sublessees. The Court stated:

“To begin with, it is a fundamental principle in contract law that a contract binds only the parties to it. The right of first refusal was embodied in the contract of lease between respondents Sawit and Orient Electronics. Petitioners were not parties to that contract.“

The Court further explained that assigning a lease requires the lessor’s consent because it involves transferring both rights and obligations. Since there was no evidence that Sawit consented to the assignment of the right of first refusal to the Sadhwanis, they could not claim this right.

“Indeed, the consent of the lessor is necessary because the assignment of lease would involve the transfer not only of rights but also of obligations. Such assignment would constitute novation by the substitution of one of the parties, i.e., the lessee.“

The Court also dismissed the Sadhwanis’ claim that Sawit’s representatives offered to sell them the property, finding insufficient evidence to support this allegation.

Practical Implications: Protecting Your Rights in Lease Agreements

This case underscores the importance of clearly defining rights and obligations in lease and sublease agreements. Sublessees should not assume that they automatically inherit all the rights granted to the original lessee. If a sublessee desires to have the right of first refusal, they must ensure that the lessor explicitly consents to the assignment of this right in writing.

For lessors, this case serves as a reminder to carefully review and approve any assignment of lease agreements. Lessors should also ensure that their lease agreements clearly state whether or not the lessee has the right to assign the lease or any of its specific provisions, like the right of first refusal.

Key Lessons

• Clarity is Key: Clearly define the rights and obligations of all parties in lease and sublease agreements.
• Lessor’s Consent: Obtain the lessor’s explicit written consent for any assignment of lease or specific rights, such as the right of first refusal.
• Sublessee Due Diligence: Sublessees should not assume they inherit all rights of the original lessee. Conduct thorough due diligence and seek legal advice.

Frequently Asked Questions

Q: What is the right of first refusal in a lease agreement?

A: The right of first refusal gives the lessee the first opportunity to purchase the property if the lessor decides to sell it. The lessor must offer the property to the lessee on the same terms and conditions as any other potential buyer.

Q: Does a sublessee automatically inherit the right of first refusal from the original lease agreement?

A: No, a sublessee does not automatically inherit the right of first refusal. The lessor must consent to the assignment of this right to the sublessee.

Q: What happens if the lessor sells the property without offering it to the lessee who has the right of first refusal?

A: The lessee may have grounds to sue the lessor for breach of contract and seek remedies such as damages or rescission of the sale.

Q: What should a sublessee do to ensure they have the right of first refusal?

A: The sublessee should obtain the lessor’s explicit written consent to the assignment of the right of first refusal. This should be clearly stated in the sublease agreement or in a separate agreement signed by all parties.

Q: Is a verbal agreement enough to transfer the right of first refusal?

A: No, a verbal agreement is generally not sufficient. It is always best to have a written agreement signed by all parties to ensure clarity and enforceability.

Q: What is the significance of Article 1311 of the Civil Code in this context?

A: Article 1311 reinforces the principle that contracts bind only the parties to them. This means that the right of first refusal, granted in the original lease agreement, only binds the lessor and the original lessee, unless the lessor consents to its assignment to the sublessee.

Q: What is the role of a lawyer in lease and sublease agreements?

A: A lawyer can help draft, review, and interpret lease and sublease agreements. They can ensure that all parties understand their rights and obligations and that the agreements comply with Philippine law.

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